Transfer PricingTransfer Pricing

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What is Transfer Pricing ? ? ?

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Objective of Transfer Price

0Optimum trade off between company cost & revenue

0To induce goal congruent decision

0To measure economic performance of individual unit

0To make the system simple to understand and easy to administer

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Fundamental Principle

“ The Transfer Price should be similar to the price that would be charged if the product were sold to outside

customers or purchased from outside vendors”

Two imperative decision :

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Sourcing Decision

Transfer Price

Decision

The Ideal Situation

0Competent people0Good atmosphere 0A market price0Freedom to serve0Full information0Negotiation

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A market price based transfer price will

induce goal congruence if all of

these conditions exits

Constraints on sourcing

1) Limited Market

0 The company is a sole producer of different product0 Company wont use outside source unless outside

source approaches to company’s variable cost0 Internal capacity and external sale

2) Excess of shortage of industry capacity

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Cost-Based transfer prices

1. How to define cost

2. How to calculate the profit markup

0 The Cost Basis0 The profit Markup

1. What the profit markup is based on

2. The level of profit allowed

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Upstream Fixed Costs and Profits

0 Agreement among Business Units0 Two-Step Pricing0 Profit Sharing0 Two sets of prices

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Pricing Corporate Services

0 For central services that the receiving unit must accept but can at least partially control the amount used.0 For central services that the business

unit can decide whether or not to use.

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Control over amount of service

E.g. Information technologyResearch & development

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Optimal use of

services

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Simplicity of The price

Mechanism

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Administration of transfer prices

0 Negotiation0 Arbitration and Conflict Resolution0 Product classification

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Thank you

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